centres. The private sector consists of dentists, specialists and a few general practitioners and nurses. The state thus employs most medical personnel. The number of health care professionals per capita is high, with Iceland ranking second

(after Finland) for both nurses and practising pharmacists, for example, among

OECD countries. Financing of health care is based on taxes, and services have no

significant user charges except for specialist care, day surgery, some pharmaceuticals and dentistry. User charges are reimbursed, however, when they exceed a certain amount by calendar year (somewhat over $200 for people aged 18 to 70,

$70 for children, and around $50 for the elderly, disabled and long-term unemployed). Nursing homes and old-age homes, which are run by municipalities or

voluntary organisations, are partly financed by user charges, but the major part of

funding is provided by the government (through health insurance or the public

pension scheme).

Given the persistent spending pressures and the apparent declining

returns in terms of marginal population health, the government has initiated some

reform measures. The last few years have seen both cutbacks and attempts to

increase the cost-effectiveness of the health care system. This has mainly concerned the hospital sector. The most important development has been the administrative merger of the three Reykjavik hospitals into one. In rural areas, health

centres have been merged with local hospitals. One recent change was the merger

of all health centres and hospitals in eastern Iceland under one board and director. In addition, the small rural hospitals have increased their collaboration with

larger ones. At the same time, there are also attempts to decentralise health care,

such as the above-mentioned experiments to transfer the responsibility for health

services to municipalities.

An important source of cost pressures has been pharmaceutical expenditure, with Iceland showing the highest growth in per capita spending over the past

30 years among the OECD countries for which data are available. Nevertheless,

the deregulation of the pharmacy sector in 1996 has led to increased competition,

as manifest in lower prices for medicines through discounts granted from the maximum permissible price. Additional cost savings for the government have resulted

from a reduction in subsidies on, and wholesale and retail margins for, medicines.

The authorities have also moved to tighten drug approval rules. As to health-care

procurement more generally, a recent report by the National Audit Office recommended that the authorities should adopt a more strategic approach to the purchase of medical services from doctors with private practices and obtain better

information on the various costs involved. The government has taken steps in this

direction. However, thought has to be given to developing a more substantial

reform package in the health-care area, while recognising the complexity of

improving efficiency without sacrificing equity. In this respect, Iceland could learn

from the lessons of attempts at health reform in other OECD countries (as

in 1998 (the most recent data available), the highest ratio among OECD countries

(Figure 17). This is a marked change from 1990, when it still was below the OECD

average. Over that period, it increased by two percentage points, more than double the corresponding rise in the OECD area. Education in Iceland has traditionally been organised within the public sector, and there are very few private

institutions, which almost all receive public funding. Public spending accounts for

about 95 per cent of total educational expenditure, little changed from 1990.

Hence, the recent boost to education spending largely reflects a government

effort. It is probably too early to expect it to be reflected in better performance.

According to the most recent available statistics, around 40 per cent of the workingage population has still not more than lower secondary education (Figure 18).

Even among young people educational attainment is well below the OECD average and considerably below the levels recorded in other Nordic countries. The

PISA study reveals, however, some improvement in educational outcomes by

international comparison. At the same time as Icelandic students have continued

to score above average in reading literacy, they now seem to be moving up toward

average performance in mathematical and scientific literacy, areas where their

achievements used to be rather poor.

Following the spurt in education expenditure, which has catapulted Iceland

from the group of low-spenders to that of high-spenders in this area, it would appear

that the focus should now be on getting better value for money. The recent conclusion of performance-related contracts with all higher-education institutions should

be helpful in this respect, although care must be taken that activity-based financing

does not lead to the provision of public services beyond the social optimum. But

there would seem to be scope for enhancing cost-efficiency in other areas. For

instance, the ratio of students to teaching staff, which is a key determinant of compensation spending, continues to be very low, except at the upper secondary level.

It should be possible to achieve better balance between students and teachers, and

thus cost savings, without jeopardising the quality of education. In any case, it may

be better policy to devote the limited resources available for education to employing more capable teachers rather than keeping class sizes low (Woessmann and

West, 2002). Moreover, public education is free of charge, even at higher levels

(except for modest enrolment fees). University students have also in most cases

access to loans from the Icelandic Student Loan Fund. Given the largely private

nature of returns to post-compulsory education, increased student fees would be

justified, the more so since access could be ensured by expanding the Loan Fund as

well as making reimbursement contingent on income. Tuition fees would encourage

students to finish their studies in good time. Indeed, the high subsidy element in